Making Your Money Last In Retirement

Quick Questions: How much can you safely withdraw each year from your retirement portfolio without the risk of running out of money before you run out of life? How much should you withdraw if you don’t want to leave too much money behind when you die?

If you’re as perplexed about answering these questions as many financial planners are, then this article will help update you on the latest research in this area of retirement planning. Saving for retirement is not easy, but using your retirement savings wisely can be just as challenging. Withdraw too much and you run the risk of running out of money. Withdraw too little and you may miss out on a more comfortable retirement lifestyle.

For more than 25 years, the most common guideline has been the “4% rule,” which suggests that a yearly withdrawal equal to 4% of the initial portfolio value, with annual increases for inflation, is sustainable over a 30-year retirement. This guideline can be helpful in projecting a savings goal and providing a realistic picture of the annual income your savings might provide. For example, a $1 million portfolio could provide $40,000 of income in the first year, with inflation-adjusted withdrawals in succeeding years.

The 4% rule has stimulated a great deal of discussion over the years, with some experts saying that 4% is too low, and others saying it’s too high. The most recent analysis comes from the man who studied it, financial professional William Bengen (widely considered in the financial planning profession as the “father of the safe withdrawal rate”), who believes the rule has been misunderstood and offers new insights based on new research.

Original Research

Bengen first published his findings in 1994, based on analyzing data for retirements beginning in 51 different years, from 1926 to 1976. He considered a hypothetical, conservative portfolio comprised of 50% large-cap stocks and 50% intermediate-term Treasury bonds held in a tax-advantaged account and rebalanced annually. A 4% inflation-adjusted withdrawal was the highest sustainable rate in the worst-case scenario — retirement in October 1968, the beginning of a bear market, and a long period of high inflation. All other retirement years had higher sustainable rates, some as high as 10% or more (1).

Of course, no one can predict the future, which is why Bengen suggested that the worst-case scenario as a sustainable rate. He later adjusted it slightly upward to 4.5%, based on a more diverse portfolio comprised of 30% large-cap stocks, 20% small-cap stocks, and 50% intermediate-term Treasuries (2).

New Research

In October 2020, Bengen published new research that attempts to project a sustainable withdrawal rate based on two key factors at the time of retirement: stock market valuation and inflation (the annual change in the Consumer Price Index). In theory, when the market is expensive, it has less potential to grow, and sustaining increased withdrawals over time may be more difficult. On the other hand, lower inflation means lower inflation-adjusted withdrawals, allowing for a higher initial rate. For example, a $40,000 first-year withdrawal becomes an $84,000 withdrawal after 20 years with a 4% annual inflation increase, but just $58,000 with a 2% annual increase.

To measure market valuation, Bengen used the Shiller CAPE, a cyclically adjusted price-earnings ratio for the S&P 500 index developed by Nobel laureate Robert Shiller. The price-earnings (P/E) ratio of a stock is the share price divided by its earnings per share for the previous 12 months. For example, if a stock is priced at $100 and the earnings per share is $4, the P/E ratio would be 25. The Shiller CAPE divides the total share price of stocks in the S&P 500 index by average inflation-adjusted earnings over 10 years.

5% rule?

Again using historical data — for retirement dates from 1926 to 1990 — Bengen found a clear correlation between market valuation and inflation at the time of retirement and the maximum sustainable withdrawal rate. Historically, rates ranged from as low as 4.5% to as high as 13%, but the scenarios that supported high rates were unusual, with very low market valuations and/or deflation rather than inflation (3).

For most of the last 25 years, the United States has experienced high market valuations, and inflation has been low since the Great Recession (4)(5). In a high-valuation, low-inflation scenario at the time of retirement, Bengen found that a 5% initial withdrawal rate was sustainable over 30 years (6). While not a big difference from the 4% rule, this suggests retirees could make larger initial withdrawals, particularly in a low-inflation environment.

One caveat is that current market valuation is extremely high: The S&P 500 index had a CAPE of 34.19 at the end of 2020, a level only reached (and exceeded) during the late-1990s dot-com boom and higher than any of the scenarios in Bengen’s research (7).  His range for a 5% withdrawal rate is a CAPE of 23 or higher, with inflation between 0% and 2.5% (8) (Inflation was 1.2% in November 2020 (9)). Bengen’s research suggests that if market valuation drops near the historical mean of 16.77, a withdrawal rate of 6% might be sustainable as long as inflation is 5% or lower. On the other hand, if valuation remains high and inflation surpasses 2.5%, the maximum sustainable rate might be 4.5% (10).

It’s important to keep in mind that these projections are based on historical scenarios and a hypothetical portfolio, and there is no guarantee that your portfolio will perform in a similar manner. Also remember that these calculations are based on annual inflation-adjusted withdrawals, and you might choose not to increase withdrawals in some years or use other criteria to make adjustments, such as market performance. For example, some retirees, in an effort to reduce withdrawals after a “down” year in the market, forego taking an inflation-based increase for the following year.

Although there is no assurance that working with a financial professional will improve your investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies, including your withdrawal strategy.

If you would like to review your current investment portfolio or discuss your current or upcoming withdrawal rate, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

(1)(2) Forbes Advisor, October 12, 2020
(3)(4)(6)(8,)(10) Financial Advisor, October 2020
(5)(9) U.S. Bureau of Labor Statistics, 2020
(7) multpl.com, December 31, 2020

Disclaimer: All investments are subject to market fluctuation, risk, and loss of principal. When sold, investments may be worth more or less than their original cost. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities fluctuates with market conditions. If not held to maturity, they could be worth more or less than the original amount paid. Asset allocation and diversification are methods used to help manage investment risk; they do not guarantee a profit or protect against investment loss. Rebalancing involves selling some investments in order to buy others; selling investments in a taxable account could result in a tax liability.

The S&P 500 index is an unmanaged group of securities considered representative of the U.S. stock market in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results. Actual results will vary.

GameStop-Shop, Chop or Slop?

By now, I’m sure you’ve heard or read about the whole GameStop stock market story in the news or online this past week.  I realize a lot of ink has already been spilled on this topic and I am not sure I can add much value or color to the discussion. Nonetheless, perhaps my added value can be to try and explain, in the simplest terms that I can muster, this craziness in the stock and derivatives market.

Let me say that the GameStop “short squeeze” debacle has had little effect on the individual investor, because we, and the majority of registered investment advisors I know, do not short-sell stocks in client portfolios. We typically only invest in blue-chip quality and solid value or growth companies, index funds, and actively managed funds. Short selling is more the domain of large hedge funds, who both buy stocks and sell stocks short. We also don’t invest in companies that were already circling the “bankruptcy drain” such as GameStop and AMC Theatres (GameStop stock traded as low as $2.57 last June).  

So what is short selling?
Short selling is betting that a stock price will go down instead of up (the exact opposite of what everyday stock investors do). To do this, traders ask their broker/dealer if they have any shares that can be borrowed from someone else’s owned shares in the broker’s inventory. If shares are available to borrow, you proceed to sell those shares (short) in the markets at their prevailing price, in hopes that their price/value goes down. Your objective is to subsequently buy them back at a lower price, and “re-pay” your borrowed shares.

Imagine this being done with millions of shares of GameStop, where so many people were already betting that the stock was going down, but instead, the stock went up these past few weeks, and went up a lot. In fact, as unbelievable as it is, more shares were sold short than the entire number of outstanding shares issued by the company (164% to be exact, so many out there were loaning shares they didn’t even have). If you’re short the shares, and they go up in price, you are said to be getting “squeezed”, and your only option is to buy back the shares at much higher prices before your broker/dealer decides that you can no longer afford to stay short, buys them back on your behalf, and charges your account for the losses (the difference between the price you sold them for and the price you paid to buy them back). Imagine selling your shares short for $65.00 per share on Friday, January 22, only to be forced to buy them back at $313 on Friday, January 29 (GameStop traded as high as $483 last week). That’s a loss of 4.8X your money (or if you were lucky and instead bought the shares, you made 4.8X your money).

What we saw this past week was a concerted effort by members of a Reddit subgroup known as Wall Street Bets (WSB) to force these short shareholders to “cover” their short positions. The whole rush to cover short shares is like tinder for a fire because the higher the shares go, the more the short shareholders have to pay to buy them back in a negative “feedback loop” for their positions. Momentum traders and other investors who see this kind of short squeeze also pile on to try and capture or “scalp” some profits.

While some large hedge fund who do/did hold short shares in client accounts lost a lot of money over the past few weeks, the majority of investment advisors and their clients were largely unaffected, other than the fact that these same hedge funds, in an attempt to ride out the short squeeze, used and sold other blue chip stocks (such as Microsoft, Apple, Johnson and Johnson) to cover their losses on the short sales. That’s why you saw the price of those stocks go down last week.

This kind of thing shall pass, and although this may be the first time you’ve heard about this type of “squeeze”, it has happened a lot in the past and will likely happen again. This type of activity tends to crop up when you have a lot of people receiving government checks who have nowhere to go and have nothing better to do (and therefore nothing to lose), so they might as well risk that money in the markets. The current COVID environment has created the perfect stock market storm. I believe that this is more media hype than substance, and will be out of the news cycle in a short time. Cries for regulating or investigating all of this are misplaced in my opinion.

In other words, it’s business as usual in the stock market, unless you owned or shorted the stocks of AMC Theatres, GameStop, Bed, Bath & Beyond, and a few others. As in other newsworthy stock markets “mania’s”, when the dust settles, the majority of the players will likely lose their money because risk management and profit protection isn’t a regular part of their stock trading discipline. If you’re a long term investor, you should grab some popcorn and enjoy the “show” from a distance, and resist the temptation to jump in and risk your hard earned money. Because when the music stops, I believe that GameStop shares will be back to trading in the low-double, if not single-digits once again.

If you would like to review your current investment portfolio or discuss short-selling, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

IRA and Retirement Plan Limits for 2021

As the year comes to and end, it is good to know the limits for 2021 contributions to IRA’s and employer retirement plans.  Many IRA and retirement plan limits are indexed for inflation each year. While some of the limits remain unchanged for 2021, other key numbers have increased.

IRA contribution limits

The maximum amount you can contribute to a traditional IRA or a Roth IRA in 2021 is $6,000 (or 100% of your earned income, if less), unchanged from 2020. The maximum catch-up contribution for those age 50 or older remains $1,000. You can contribute to both a traditional IRA and a Roth IRA in 2021, but your total contributions cannot exceed these annual limits.

Income limits for deducting traditional IRA contributions

If you (or if you’re married, both you and your spouse) are not covered by an employer retirement plan, your contributions to a traditional IRA are generally fully tax deductible. If you’re married, filing jointly, and you’re not covered by an employer plan but your spouse is, your deduction is limited if your modified adjusted gross income (MAGI) is between $198,000 and $208,000 (up from $196,000 and $206,000 in 2020), and eliminated if your MAGI is $208,000 or more (up from $206,000 in 2020).

For those who are covered by an employer plan, deductibility depends on your income and filing status.

If your 2021 federal income tax  filing status is: Your IRA deduction is limited if your MAGI is  between: Your deduction is eliminated if your MAGI is:
Single or head of household $66,000 and $76,000 $76,000 or more
Married filing jointly or qualifying  widow(er) $105,000 and $125,000 (combined) $125,000 or more  (combined)
Married filing separately $0  and $10,000 $10,000 or more

If your filing status is single or head of household, you can fully deduct your IRA contribution up to $6,000 ($7,000 if you are age 50 or older) in 2021 if your MAGI is $66,000 or less (up from $65,000 in 2020). If you’re married and filing a joint return, you can fully deduct up to $6,000 ($7,000 if you are age 50 or older) if your MAGI is $105,000 or less (up from $104,000 in 2020).

Income limits for contributing to a Roth IRA

The income limits for determining how much you can contribute to a Roth IRA have also increased.

If your 2021 federal income tax  filing status is: Your Roth IRA contribution is limited if your MAGI  is: You cannot contribute to a Roth IRA if your MAGI is:
Single or head of household More than $125,000 but less than $140,000 $140,000 or more
Married filing jointly or qualifying  widow(er) More than $198,000 but less than $208,000  (combined) $208,000 or more (combined)
Married filing separately More  than $0 but less than $10,000 $10,000 or more

If your filing status is single or head of household, you can contribute the full $6,000 ($7,000 if you are age 50 or older) to a Roth IRA if your MAGI is $125,000 or less (up from $124,000 in 2020). And if you’re married and filing a joint return, you can make a full contribution if your MAGI is $198,000 or less (up from $196,000 in 2020). Again, contributions can’t exceed 100% of your earned income.

Employer retirement plan limits

Most of the significant employer retirement plan limits for 2021 remain unchanged from 2020. The maximum amount you can contribute (your “elective deferrals”) to a 401(k) plan remains $19,500 in 2021. This limit also applies to 403(b) and 457(b) plans, as well as the Federal Thrift Plan. If you’re age 50 or older, you can also make catch-up contributions of up to $6,500 to these plans in 2021. [Special catch-up limits apply to certain participants in 403(b) and 457(b) plans.]

The amount you can contribute to a SIMPLE IRA or SIMPLE 401(k) remains $13,500 in 2021, and the catch-up limit for those age 50 or older remains $3,000.

Plan type: Annual dollar limit: Catch-up limit:
401(k), 403(b), governmental 457(b),  Federal Thrift Plan $19,500 $6,500
SIMPLE  plans $13,500 $3,000

Note: Contributions can’t exceed 100% of your earned income.

If you participate in more than one retirement plan, your total elective deferrals can’t exceed the annual limit ($19,500 in 2021 plus any applicable catch-up contributions). Deferrals to 401(k) plans, 403(b) plans, and SIMPLE plans are included in this aggregate limit, but deferrals to Section 457(b) plans are not. For example, if you participate in both a 403(b) plan and a 457(b) plan, you can defer the full dollar limit to each plan — a total of $39,000 in 2021 (plus any catch-up contributions).

The maximum amount that can be allocated to your account in a defined contribution plan [for example, a 401(k) plan or profit-sharing plan] in 2021 is $58,000 (up from $57,000 in 2020) plus age 50 or older catch-up contributions. This includes both your contributions and your employer’s contributions. Special rules apply if your employer sponsors more than one retirement plan.

Finally, the maximum amount of compensation that can be taken into account in determining benefits for most plans in 2021 is $290,000 (up from $285,000 in 2020), and the dollar threshold for determining highly compensated employees (when 2021 is the look-back year) remains $130,000 (unchanged from 2020).

If you would like to review your current investment portfolio or discuss 2021 IRA contributions, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

Year-End Tax Planning for 2020 (Business)

In December of 2019, the Further Consolidated Appropriations Act, 2020, was signed into law. Included in that new law was the SECURE Act of 2019, which not only extended certain expiring tax credits, such as the employer credit for paid family and medical leave, it also made favorable changes to certain provisions relating to employer-provided retirement plans.

In 2020, the first piece of COVID-19 legislation signed into law was the Families First Coronavirus Response Act (Families First Act), which responded to the coronavirus outbreak by providing, among other things, payroll tax credits for leave required to be paid under the newly enacted Emergency Paid Sick Leave Act (EPSLA) and Emergency Family and Medical Leave Expansion Act (EFMLEA). The Families First Act was followed by the biggest piece of legislation for the year – the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). Included in the CARES Act was the Paycheck Protection Program (PPP), a program authorized by the Small Business Administration (SBA) to guarantee $349 billion in new loans to eligible businesses and nonprofits affected by coronavirus/COVID-19. Such loans may also qualify for tax-free loan forgiveness. We need to evaluate the changes made by the CARES Act, as well as subsequent coronavirus-related legislation, to determine their impact on your business’s tax liability. The following are some of the considerations we need to review when deciding what year-end actions may be appropriate to reap the most benefit to you and your business’s bottom line.

Depreciation Deductions

Among the many changes made by the CARES Act, the one which may have the most impact is the correction of a technical error made in the Tax Cuts and Jobs Act of 2017 (TCJA). That error resulted in the 15-year recovery period that applied to qualified leasehold improvements, qualified restaurant property, and qualified retail improvement property being eliminated for such property placed in service after 2017. After the TCJA, the depreciation period for such property, now referred to as “qualified improvement property,” was 39 years and, as a result, did not meet the requirements for additional first-year depreciation (i.e., bonus depreciation). Under the CARES Act, qualified improvement property is now depreciated over a 15-year life and meets the criteria for taking bonus depreciation. The change is effective as if it were included in the TCJA. Thus, if your business is affected by this change, we can file amended returns to claim refunds for the deductions that should have been available to you had the technical error not happened.

Relaxed Rules for Deducting Net Operating Losses

The CARES Act also temporarily removed the 80 percent limitation on taxable income for deducting net operating losses (NOLs) for 2020. In addition, the CARES Act amended the rules for NOLs to provide for a five-year carryback of any NOL arising in 2018, 2019, and 2020. As a result, if applicable, your business can take such NOLs into account in the earliest tax year in the carryback period and carry forward unused amounts to each succeeding tax year. Alternatively, you can waive this carryback period and instead carry forward any NOLs to offset income in future years. Depending on expected tax rates and cash flow in future years, this waiver option may make more sense than carrying back any NOLs.

Reduction in Business Interest Limitation

The CARES Act reduced the limitation on the deductibility of business interest. For tax years beginning in 2019 or 2020, 50 percent of a business’s adjusted taxable income, rather than 30 percent, is used to determine the business interest limitation. A special rule is provided for partnerships. Under this special rule, the increase in the limitation to 50 percent of adjusted taxable income in determining the business interest limitation does not apply to a partnership for 2019, subject to certain rules relating to allocations to the partners. There is also an election under which a business can substitute its adjusted taxable income for its last tax year beginning in 2019 for its adjusted taxable income for 2020 in calculating the business interest limitation for 2020. Keep in mind that the business interest deduction limitation only applies if the gross receipts of your business exceed $26 million in 2019 and 2020; Additionally, certain types of businesses are exempt from the limitation.

Modification of Excess Business Loss Limitation Rules

The CARES Act eliminated certain limitations on excess farm losses of a business other than a corporation. This change applies to any tax year beginning after December 31, 2017, and before January 1, 2026. Thus, if you had such losses that were limited in 2018 and/or 2019, we may be able to obtain tax refunds with respect to those years. Further, excess business losses, previously disallowed for tax years beginning after December 31, 2017, and before January 1, 2026, are now allowed for tax years beginning after 2017 and before January 1, 2021. This also presents an opportunity for amended tax returns if it applies to your business.

Minimum Tax Credit Refund

The CARES Act modified the rules for the minimum tax credit for alternative minimum tax (AMT) incurred by a corporation in a prior tax year. Under this provision, the limitation on the credit for prior year minimum tax liability does not apply to a corporation’s 2020 and 2021 tax years and the AMT refundable credit amount is 100 percent, rather than 50 percent, for tax years beginning in 2019. In addition, a corporation can elect to take the entire refundable credit amount in 2018. A corporation can apply for a tentative refund of any amount for which a refund is due by reason of this new election and, within 90 days, the IRS is required to review the application, determine the amount of the overpayment, and apply, credit, or refund the overpayment.

Retirement Plans and Other Employee Benefits

You can reap substantial tax benefits, as well as non-tax benefits, by offering a retirement plan and/or other fringe benefits to employees. Businesses that offer such benefits have a better chance of attracting and retaining talented workers. This, in turn, reduces the costs of searching for and training new employees. Contributions made to retirement plans on behalf of employees are deductible and you may be eligible for a tax credit for setting up a qualified plan. In addition, business owners can take advantage of the retirement plan themselves, as can their spouse. Where a spouse is not currently on the payroll of a business, consideration should be given to adding the spouse as an employee and paying a salary up to the maximum amount that can be deferred into a retirement plan. So, for example, if your spouse is 50 years old or over and receives a salary of $25,000, all of it could go into a 401(k), leaving him or her with a retirement account but no taxable income.

To help employees with medical expenses, your business might consider setting up a high deductible health plan paired with a health savings account (HSA). The benefits to a business include savings on health insurance premiums that would otherwise be paid to traditional health insurance companies and having employee wage contributions to the plan not being counted as wages and thus neither the employer nor the employee is subject to FICA taxes on the payroll contributions. As for employees, they can reap a tax deduction for funds contributed to the HSA, which they can invest the funds for future medical costs because there is no use-it-or-lose-it limit like there is for most flexible spending accounts; thus the funds can grow tax free and be used in retirement.

Your business might also consider establishing a flexible spending arrangement (FSA) which allows employees to be reimbursed for medical expenses and is usually funded through voluntary salary reduction agreements with the employer. The employer has the option of making or not making contributions to the FSA. Some of the benefits of an FSA include the fact that contributions made by the business can be excluded from the employee’s gross income, no employment or federal income taxes are deducted from the contributions, reimbursements to the employee are tax free if used for qualified medical expenses, and the FSA can be used to pay qualified medical expenses even if the employer or employee haven’t yet placed the funds in the account.

In addition, the SECURE Act made substantial changes to retirement plan-related provisions from which your business may benefit. For one, it increased the credit available for small employer pension plan startup costs. The credit is available for qualified startup costs of an eligible small employer that adopts a new qualified retirement plan, SIMPLE IRA plan, or SEP, provided that the plan covers at least one non-highly compensated employee. Qualified startup costs are expenses connected with the establishment or administration of the plan or retirement-related education for employees with respect to the plan. The credit, which applies for up to three years, was increased to the lesser of (1) a flat dollar amount of $500 per year, or (2) 50 percent of the qualified startup costs.

The SECURE Act also extended through 2020 an employer credit for paid family and medical leave. The credit allows eligible employers to claim a general business credit equal to an applicable percent of the amount of wages paid to qualifying employees during any period in which such employees are on family and medical leave, provided that the rate of payment under the program is at least 50 percent of the wages normally paid to an employee.

The SECURE Act also extended the work opportunity credit through 2020. Under this provision, an employer can take a 40 percent credit for qualified first-year wages paid or incurred with respect to employees who are members of a targeted group of employees.

Qualified Business Income Deduction

If you participate in a business as sole proprietor, a partner in a partnership, a member in an LLC taxed as a partnership, or as a shareholder in an S corporation, you may be eligible for the qualified business income (QBI) deduction. The QBI deduction is generally 20 percent of qualifying business income from a qualified trade or business. A W-2 wage limitation amount may apply to limit the amount of the deduction. The W-2 wage limitation amount must be calculated for taxpayers with a taxable income that exceeds a statutorily-defined amount (i.e., the threshold amount). For any tax year beginning in 2020, the threshold amount is $326,600 for married filing joint returns, $163,300 for married filing separate returns, and $163,300 for all other returns.

The QBI deduction reduces taxable income, and is not used in computing adjusted gross income. Thus, it does not affect limitations based on adjusted gross income. The QBI deduction does not apply to a “specified service trade or business,” which is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.

Some of the categories and fields listed as a specified service trade or business are fairly clear in their meaning. Others – such as “consulting” and “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees” – are more vague. If your business could be considered a specified service trade or business, we will need to document why it should not be considered such a business and is thus eligible for the QBI deduction.

Employee Payroll Tax Deferrals

In a Payroll Tax Memorandum issued in August, President Trump directed Treasury Secretary Mnuchin to use his authority to defer the withholding, deposit, and payment of employee social security taxes, as well as taxes imposed under the Railroad Retirement Tax Act (RRTA) on railroad employees, for the period of September 1, 2020, through December 31, 2020. Because these taxes are not forgiven, and must be repaid at the end of the year, such a deferral could result in numerous practical challenges, such as what happens if an employee leaves before he or she repays the payroll taxes. If you have deferred an employee’s payroll taxes under this Presidential directive, we need to discuss your options.

Extension of Time to Pay Employment Taxes

Under the CARES Act, a business can delay payment of applicable employment taxes for the period beginning on March 27, 2020, and ending before January 1, 2021 (i.e., the payroll tax deferral period). Generally, under this provision, the business is treated as having timely made all deposits of applicable employment taxes that would otherwise be required during the payroll tax deferral period if all such deposits are made not later than the “applicable date,” which is (1) December 31, 2021, with respect to 50 percent of the amounts due, and (2) December 31, 2022, with respect to the remaining amounts. For self-employed taxpayers, the payment for 50 percent of the self-employment taxes for the payroll tax deferral period is not due before the applicable date. For purposes of applying the penalty for underpayment of estimated income taxes to any tax year which includes any part of the payroll tax deferral period, 50 percent of the self-employment taxes for the payroll tax deferral period are not treated as taxes to which that penalty applies.

PPP Loan

If your business obtained funds through the PPP program, we should discuss the steps and documentation necessary to ensure that your loan is fully forgiven.

Impact of Future Tax Legislation

Because it is unclear what, if any, tax legislation may be coming next year, we’ll need to base our year-end planning on existing law.

If you would like to review your current investment portfolio or discuss any other financial or tax planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first. If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

2020 Year-End Tax Planning Tips & Traps

It’s that time of year again! Well, yes, it’s that magical holiday time of year too, but year-end tax planning season is upon us.

Because of uncertainty surrounding the two vacant Georgia Senate seats scheduled for a runoff election on January 5, 2021, it’s unclear whether any of presumed President-elect Biden’s tax proposals (increases) will become law in 2021. If the Republicans can capture at least one of the two Georgia Senate seats and maintain control of the Senate, then tax increases in 2021 will be harder to pass under a split Congress.

Due to the coronavirus pandemic (COVID-19) and the enactment of legislation to offset the economic burden wrought by COVID-19, as well as a legislation passed at the end of 2019, there is a lot to consider when reviewing year-end tax planning options that may be available to reduce your 2020 or 2021 tax liability.

In December of 2019, the SECURE Act was signed into law. This legislation extended several expiring deductions and tax credits and provided some taxpayer-friendly changes to retirement-related rules. In 2020, the first piece of COVID-19 tax-related legislation signed into law was the Families First Coronavirus Response Act (Families First Act), which responded to the coronavirus outbreak by providing, among other things, four types of tax credits for employers and self-employed individuals.

The Families First Act was followed by the biggest piece of legislation for the year – the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The CARES Act, as well as subsequent coronavirus-related legislation, will most likely impact your tax return in some way. The following are some of the considerations we should explore when discussing the tax breaks from which you may benefit, as well as the strategies we can employ to help minimize your taxable income and resulting federal tax liability.

Effect of CARES Act Rebate on Your 2020 Tax Return

Under the CARES Act, individuals with income under a certain level are entitled to a recovery rebate tax credit. These are direct payments (sometimes referred to as “stimulus checks”) to individuals by the government. Most, but not all, of these stimulus checks have already been sent out to eligible individuals during 2020.

Single individuals and joint filers are entitled to a payment of $1,200 or $2,400, respectively, plus $500 for each qualifying child. The term “qualifying child” has the same meaning that it does for the child tax credit. Thus, a qualifying child can be no older than 16 on the last day of the tax year (December 31, 2020). The amount of the recovery rebate phases out for income over a certain level. The rebate is reduced by 5 percent of the amount by which the taxpayer’s adjusted gross income exceeds (1) $150,000 in the case of a joint return, (2) $112,500 in the case of a head of household, and (3) $75,000 in the case of a single taxpayer or a taxpayer with a filing status of married filing separately.

The government issued the rebates based on 2019 income tax returns, or 2018 returns for individuals who had not yet filed their 2019 tax return. The calculation for the correct amount of the rebate will be part of your 2020 tax return. If your 2020 tax return indicates a rebate larger than your stimulus check (because, for example, your income went down or you had another child), any additional amount can be claimed as a credit against your 2020 tax bill. In an unusual twist in the legislation, if the 2020 rebate calculation shows an amount in excess of what you were entitled to, you do not have to repay that excess.

Filing Status

Your tax return filing status can impact the amount of taxes you pay. For example, if you qualify for head-of-household (HOH) filing status, you are entitled to a higher standard deduction and more favorable tax rates. To qualify as HOH, you must be unmarried or considered unmarried (i.e., legally separated or living apart from a spouse) and provide a home for certain other persons. If you are in such a situation, you need to review whether you qualify for HOH filing status.

If you are married, you’ll either be filing your return using the married filing jointly or married filing separately filing status. Generally, married filing separately is not beneficial for tax purposes, but in some unique cases, such as when one party earns substantially less or when one party may be subject to IRS penalties for issues relating to their tax reporting, it may be advantageous to file as married filing separately. Additionally, if one spouse was not a full-year U.S. resident, an election is available to file a joint tax return where such joint filing status would otherwise not apply, and this may help reduce a couple’s tax liability.

Note that once you file your return jointly, you cannot subsequently go back and amend your return to file separately, but you can switch status from married filing separately to married filing jointly.

Income, Deductions, and Credits

Income from Repayment of Student Loan Debt: The CARES Act excludes from income certain student loan debt repaid by an individual’s employer. Thus, if an employer repaid some or all of your student loan debt after March 27, 2020, and before 2021, that repayment, which would otherwise be taxable income to you, is not includible in your income.

Standard Deduction versus Itemized Deductions: The Tax Cuts and Jobs Act of 2017 (TCJA) substantially increased the standard deduction amounts, thus making itemized deductions less attractive for many individuals. For 2020, the standard deduction amounts are: $12,400 (single); $18,650 (head of household); $24,800 (married filing jointly); and $12,400 (married filing separately).

If the total of your itemized deductions in 2020 will be close to your standard deduction amount, you should evaluate whether alternating between bunching itemized deductions into 2020 and taking the standard deduction in 2021 (or vice versa) could provide a net-tax benefit over the two-year period. For example, you might consider doubling up this year on your charitable contributions rather than spreading the contributions over a two-year period (or look into setting up a Donor Advised Fund). If these contributions, along with your mortgage interest, medical expenses (discussed below), and state/local income and property taxes (subject to the $10,000 deduction limitation on such taxes that applies to both single individuals and married couples filing jointly; and the $5,000 limitation on such expenses for married filing separately returns), exceed your standard deduction, then itemizing such expenses this year and taking the standard deduction next year may be appropriate.

Medical Expenses Health Savings Accounts, and Flexible Savings Accounts: For 2020, your medical expenses are deductible as an itemized deduction to the extent that they exceed 7.5 percent of your adjusted gross income. To be deductible, medical care expenses must be primarily to alleviate or prevent a physical or mental disability or illness. They don’t include expenses that are merely beneficial to general health, such as vitamins or a vacation.

Deductible expenses include the premiums you pay for insurance that covers the expenses of medical care, and the amounts you pay for transportation to get medical care. Medical expenses also include amounts paid for qualified long-term care services and limited amounts paid for any qualified long-term care insurance contract. Depending on what your taxable income is expected to be in 2020 and 2021, and whether itemizing deductions would be advantageous for you in either year, you may want to accelerate any optional medical expenses into 2020 or defer them until 2021. The right approach depends on your income for each year, expected medical expenses, as well as your other itemized deductions.

You may also want to consider health saving accounts (HSAs) if you don’t already have one. These are tax-advantaged accounts which help individuals who have high-deductible health plans (HDHPs). If you are eligible to set up such an account, you can deduct the amount you contribute to the account in computing adjusted gross income. These contributions are deductible whether you itemize deductions or not. Distributions from an HSA are tax free to the extent that they are used to pay for qualified medical expenses (i.e., medical, dental, and vision expenses). For 2020, the annual contribution limits are $3,550 for an individual with self-only coverage and $7,100 for an individual with family coverage.

In addition, if you are not already doing so and your employer offers a Flexible Spending Account (FSA), consider setting aside some of your earnings tax free in such an account so you can pay medical and dental bills with pre-tax money. The maximum amount that the IRS will allow to be set aside in 2021 is expected to be $2,750. Since you don’t pay taxes on this money, you’ll save an amount equal to the taxes you would have paid on the money that you set aside. FSA funds can be used to pay deductibles and co-payments, but not for insurance premiums. You can also spend FSA funds on prescription medications, as well as over-the-counter medicines, generally with a doctor’s prescription. Reimbursements for insulin are allowed without a prescription. And finally, FSAs may also be used to cover costs of medical equipment like crutches, supplies like bandages, contact lenses and diagnostic devices like blood sugar test kits.

Several CARES Act provisions affect health care related rules. For example, under the CARES Act, an HDHP temporarily can cover tele-health and other remote care services without a deductible, or with a deductible below the minimum annual deductible otherwise required by law. The CARES Act also modified the rules that apply to various tax-advantaged health-related accounts so that additional health-related items are “qualified medical expenses” that may be reimbursed from those accounts. Under the new rules, which apply to amounts paid after 2019, over-the-counter products and medications are now reimbursable without a prescription.

Charitable Contributions: While the tax benefits of making charitable contributions and taking an itemized deduction for such contributions were tamped down as a result of the increase in the standard deduction in the TCJA, the CARES Act modified the charitable contribution rules for 2020 tax returns. As a result, an eligible individual can claim an above-the-line deduction of up to $300 for qualified charitable contributions made during 2020. The above-the-line deduction is not available for contributions made after 2020. An eligible individual is an individual who does not elect to itemize deductions. Thus, absent this provision, anyone taking the standard deduction would be ineligible to take a charitable contribution deduction. A qualified charitable contribution is a cash contribution paid in 2020 to an eligible charitable organization. Contributions of non-cash property, such as securities, are not qualified contributions.

In addition, if you are itemizing your deductions and have substantial charitable contributions, the CARES Act modified the percentage limitation rules that could otherwise limit your charitable contribution deduction. Under the provision, for charitable contributions made during 2020, any qualified contribution is allowed as a deduction to the extent that the aggregate of such contributions does not exceed the excess of your charitable contribution base over the amount of all other charitable contributions. Excess contributions are eligible for a five-year carryover.

As in prior years, you can reap a larger tax benefit by donating appreciated assets, such as stock, to a charity. Generally, the higher the appreciated value of an asset, the bigger the potential value of the tax benefit. Donating appreciated assets not only entitles you to a charitable contribution deduction but also helps you avoid the capital gains tax that would otherwise be due if you sold your stock.

For example, if you own stock with a fair market value of $1,000 that was purchased for $250 and your capital gains tax rate is 15 percent, the capital gains tax you would owe is $113 ($750 gain x 15%). If you donate that stock instead of selling it, and are in the 24 percent tax bracket, your ordinary income deduction is worth $240 ($1,000 FMV x 24% tax rate). You also save the $113 in capital gains tax that you would otherwise pay if you sold the stock; that amount goes to the charity. Thus, the after-tax cost of the gift of appreciated stock is $647 ($1,000 – $240 – $113) compared to the after tax cost of a donation of $1,000 cash which would be $760 ($1,000 – $240). However, it’s important to also keep in mind that tax deductions for contributions of appreciated long-term capital gain property may be limited to a certain percentage of your adjusted gross income depending on the amount of the deduction.

Finally, if you have an individual retirement account and are 70 1/2 years old and older, you are eligible to make a charitable contribution directly from your IRA (even though the age for required minimum distributions is now age 72). This is more advantageous than taking a distribution and making a donation to the charity that may or may not be deductible as an itemized deduction. If your itemized deductions, including the contribution, are less than your standard deduction, then you receive no tax benefit from making the donation in this manner. By making the donation directly from your IRA to a charity, you eliminate having the IRA distribution included in your income. This in turn reduces your adjusted gross income (AGI).

And because various tax-related items, such as the medical expense deduction, the taxability of social security income, or the 3.8 percent net investment income tax are calculated based on your AGI, a reduced AGI can potentially increase your medical expense deduction, reduce the taxes on social security income, and reduce any net investment income tax.

Expenses Incurred While Working from Home: Although more people have been working from home this year due to the pandemic, related expenses are not deductible if you are an employee. The TCJA eliminated the deductibility of such expenses when it suspended the deduction for miscellaneous itemized expenses that was available before 2018. However, if you are self-employed and worked from home during the year, tax deductions are still available. Thus, if you have been working from home as an independent contractor, some office in the home expenses you have incurred might reduce your taxable income.

Mortgage Interest Deduction: If you sold your principal residence during the year and acquired a new principal residence, the deduction for any interest on your acquisition indebtedness (i.e., your mortgage) could be limited. The mortgage interest deduction on mortgages of more than $750,000 obtained after December 14, 2017, is limited to the portion of the interest allocable to $750,000 ($375,000 in the case of married taxpayers filing separately). If you have a mortgage on a principle residence acquired before December 15, 2017, the limitation applies to mortgages of $1,000,000 ($500,000 in the case of married taxpayers filing separately) or less. However, if you operate a business from your home, an allocable portion of your mortgage interest is not subject to these limitations.

Interest on Home Equity Indebtedness: You can potentially deduct interest paid on home equity indebtedness, but only if you used the debt to buy, build, or substantially improve your home. Thus, for example, interest on a home equity loan used to build an addition to your existing home is typically deductible, while interest on the same loan used to pay personal expenses, such as credit card debt, is not.

Sale of a Home: If you sold your home this year, up to $250,000 ($500,000 for married filing jointly) of the gain on the sale is excludible from income. However, this amount is reduced if part of your home was rented out or used for business purposes. Generally, a loss on the sale of a home is not deductible. But again, if you rented part of your home or otherwise used it for business, the loss attributable to that portion of the home may be deductible.

Discharge of Qualified Principal Residence Indebtedness: If you had any qualified principal residence indebtedness which was discharged in 2020, it is not includible in gross income.

Deductions for Mortgage Insurance Premiums: You may be entitled to treat amounts paid during the year for any qualified mortgage insurance as deductible qualified residence interest, if the insurance was obtained in connection with acquisition debt for a qualified residence.

Deductions for Excess Business Losses: The CARES Act removed the loss limitation deduction applicable to non-corporate taxpayers who incurred excess business losses in 2018, 2019, and 2020. An excess business loss for the tax year is the excess of aggregate deductions attributable to your trades or businesses over the sum of your aggregate gross income or gain plus a threshold amount. The threshold amount for 2020 is $259,000 or $518,000 for joint returns. If this provision affects you, you can file amended returns and claim refunds for the years affected.

Qualified Business Income Passthrough Tax Break: Under the qualified business income tax break, a 20 percent deduction is allowed for qualified business income from sole proprietorships, S corporations, partnerships, and LLCs taxed as partnerships. If you qualify for the deduction, which is available to both itemizers and nonitemizers, it is taken on your individual tax return as a reduction to taxable income. This tax break is subject to some complicated restrictions and limitations, but the rules that apply to individuals with taxable income at or below $163,300 ($326,600 for joint filers; $163,300 for married individuals filing separately) are simpler and more permissive than the ones that apply above those thresholds.

Child and Dependent Tax Credit: For 2020, you may claim as much as a $2,000 credit for each child under age 17. The amount of the credit is reduced for taxpayers with modified adjusted income over $200,000 ($400,000 for married filing jointly) and eliminated in full for taxpayers with modified adjusted gross income over $240,000 ($440,000 for married filing jointly). In addition, you may be eligible for a $500 credit for certain dependents. The $500 credit applies to two categories of dependents: (1) qualifying children for whom a child tax credit is not allowed (because, for example, you do not have a social security number for that child), and (2) certain qualifying relatives.

Education-Related Deductions and Credits: Certain education-related tax deductions, credits, and exclusions from income may apply for 2020. Tax-free distributions from a qualified tuition program, also referred to as a Section 529 plan, of up to $10,000 are allowed for qualified higher education expenses. Qualified higher education expenses for this purpose include tuition expenses in connection with a designated beneficiary’s enrollment or attendance at an elementary or secondary public, private, or religious school, i.e. kindergarten through grade 12. It also includes expenses for fees, books, supplies, and equipment required for the participation in certain apprenticeship programs and qualified education loan repayments in limited amounts.

A special rule allows tax-free distributions to a sibling of a designated beneficiary (i.e., a brother, sister, stepbrother, or stepsister). As a result, a 529 account holder can make a student loan distribution to a sibling of the designated beneficiary without changing the designated beneficiary of the account. In addition, if your modified adjusted gross income level is below certain thresholds, the following are also available for 2020: a deduction of up to $4,000 for qualified tuition and related expenses, an exclusion from income for education savings bond interest received; a deduction for student loan interest; and a lifetime learning credit of up to $2,000 for tuition and fees paid for the enrollment or attendance of yourself, your spouse, or your dependents for courses of instruction at an eligible educational institution.

Credit for Sick Leave for Self-Employed Individuals: Under the Families First Act, if you are considered an eligible self-employed individual, you may be eligible for an income tax credit for a qualified sick leave equivalent amount. You are an eligible self-employed individual if you regularly carry on any trade or business and would be entitled to receive paid leave during the tax year under the Emergency Paid Sick Leave Act added by the Families First Act.

The calculation of the qualified sick leave equivalent amount is quite complicated but is generally equal to the number of days during the tax year that you could not perform services for which you would have been entitled to sick leave, multiplied by the lesser of two amounts: (1) $511, or (2) 100 percent of your average daily self-employment income. The number of days taken into account in determining the qualified sick leave equivalent amount may not generally exceed 10 days. Your average daily self-employment income under this provision is an amount equal to the net earnings from self-employment for the year divided by 260. In addition, if you have appropriate documentation, the credit is refundable.

Credit for Family Leave for Certain Self-Employed Individuals: Another income tax credit that may be available to you under the Families First Act is a credit for a qualified family leave equivalent amount. The qualified family leave equivalent amount is an amount equal to the number of days (up to 50) during the tax year that you could not perform services for which you would be entitled, if you were employed by an employer, to paid leave under the Emergency Family and Medical Leave Expansion Act, which was added by the Families First Act, multiplied by the lesser of two amounts: (1) 67 percent of your average daily self-employment income for the tax year, or (2) $200. Your average daily self-employment income under the provision is an amount equal to your net earnings from self-employment for the year divided by 260. This credit is also refundable.

Retirement Planning

CARES Act and SECURE Act Changes. Several taxpayer-favorable changes were made in the CARES Act and the SECURE Act with respect to retirement plans and distributions from those plans including the following:

(1) The required minimum distribution rules for 2020 are waived so no one is required to take such a distribution and include it in taxable income in 2020.

(2) The age limit for making contributions to a traditional individual retirement account (IRA), previously 70 ½ years old, was repealed in 2020. Thus, anyone who is otherwise eligible may make a contribution to a traditional IRA.

(3) A new type of retirement plan distribution was added to the list of early distributions that are excepted from the 10-percent penalty for early withdrawals. You can now receive a distribution from an applicable eligible retirement plan of up to $5,000 without penalty if the distribution is either a qualified birth or adoption distribution.

(4) Taxpayers impacted by the coronavirus (which is essentially anyone) can withdraw up to $100,000 from a retirement plan without penalty and is generally includible in income over a three-year period and, to the extent the distribution is eligible for tax-free rollover treatment and is contributed to an eligible retirement plan within a three-year period, is not includible in income.

(5) The required beginning date for required minimum distributions has been increased to 72 years old from 70 ½ years old. The former rules apply to employees and IRA owners who attained age 70½ prior to January 1, 2020. The new provision is effective for distributions required to be made after December 31, 2019, with respect to individuals who attain age 70½ after December 31, 2019.

Retirement Plan Contributions: If you can afford to do so, investing the maximum amount allowable in a qualified retirement plan will yield a large tax benefit. If your employer has a 401(k) plan and you are under age 50, you can defer up to $19,500 of income into that plan for 2020. Catch-up contributions of $6,500 are allowed if you are 50 or over. If you have a SIMPLE 401(k), the maximum pre-tax contribution for 2020 is $13,500. That amount increases to $16,500 if you are 50 or older. The maximum IRA deductible contribution for 2020 is $6,000 and that amount increases to $7,000 if you are 50 or over.

Life Events

Life events can have a significant impact on your tax liability. For example, if you are eligible to use head of household or surviving spouse filing status for 2019, but will change to a filing tax status of single for 2020, your tax rate will go up. If you married or divorced during the year and changed your name, you need to notify the Social Security Administration (SSA). Similarly, the SSA should be notified if you have a dependent whose name has been changed. A mismatch between the name shown on the tax return and the SSA records can cause problems in the processing of tax returns and may even delay tax refunds. Let me know if you have been impacted by a life event, such as a birth or death in your family, the loss of a job or a change in jobs, or a retirement during the year. All of these can affect you tax situation.

Impact of Future Legislation

Because it is unclear what, if any, tax legislation may be coming next year, you’ll need to base your year-end planning on existing tax law. Be sure to check themoneygeek.com for updates on any potential law changes.

An article on business tax planning will be posted next week, so be sure to return and read those tips if you own or run a business.

If you would like to review your current investment portfolio or discuss any other financial or tax planning matters, please don’t hesitate to contact us or visit our website at ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

 

Election Confusion Designed to Steal Your Data and Assets

Criminals are using election confusion to attempt to steal your data and assets. Don’t become a victim!

As we near the end of the year, we’re all reminded once again that fraud attempts tend to spike during the holiday season. But this year’s fourth quarter offers additional reasons for concern—not only due to the ongoing global pandemic, but also because of tensions surrounding the U.S. presidential election.

Fraudsters are already doing their best to take advantage of voters’ confusion about how, where and when they can cast their ballots in a disorienting and seemingly unpredictable environment. For example, there are already reports of fraudulent websites that are offering inaccurate mail-in voting guidelines, as well as fallacious robocalls purporting to be from presidential candidates.

We anticipate that, as election day approaches, fraudsters will try not only the techniques mentioned above, but also phishing campaigns and other scams designed to steal your personal and account information, infect your devices with malware, and gain access to your email and financial accounts.

Be sure that you are aware of these threats and are ready to defend against them. Here are some tips:

  • Always pause and ask additional questions when something doesn’t seem right.
  • Hang up on strangers who call you asking personal questions
  • Never open an e-mail attachment that you’re not 100% sure is legitimate or you were not expecting.

As a firm, we are doing everything we can to help prevent fraud, among others by verifying money movement between client internal and external accounts. We will always verbally verify wire transfers before approving them and will do our best to flag unusual activity with the help of our custodian.

Medicare Open Enrollment Begins October 15

What is the Medicare Open Enrollment Period?

The Medicare Open Enrollment Period is the time during which Medicare beneficiaries can make new choices and pick plans that work best for them. Each year, Medicare plan costs and coverage typically change. In addition, your health-care needs may have changed over the past year. The open enrollment period is your opportunity to switch Medicare health and prescription drug plans to better suit your needs.

When does the Medicare Open Enrollment Period start?

The annual Medicare Open Enrollment Period begins on October 15 and runs through December 7. Any changes made during open enrollment are effective as of January 1, 2020.

During the open enrollment period, you can:

  • Join a Medicare prescription drug (Part D) plan
  • Switch from one Part D plan to another Part D plan
  • Drop your Part D coverage altogether
  • Switch from Original Medicare to a Medicare Advantage plan
  • Switch from a Medicare Advantage plan to Original Medicare
  • Change from one Medicare Advantage plan to a different Medicare Advantage plan
  • Change from a Medicare Advantage plan that offers prescription drug coverage to a Medicare Advantage plan that doesn’t offer prescription drug coverage
  • Switch from a Medicare Advantage plan that doesn’t offer prescription drug coverage to a Medicare Advantage plan that does offer prescription drug coverage

What should you do?

Now is a good time to review your current Medicare plan. What worked for you last year may not work for you this year.

Have you been satisfied with the coverage and level of care you’re receiving with your current plan? Are your premium costs or out-of-pocket expenses too high? Has your health changed?  Do you anticipate needing medical care or treatment, or new or pricier prescription drugs?

If your current plan doesn’t meet your health-care needs or fit within your budget, you can switch to a plan that may work better for you.

If you find that you’re still satisfied with your current Medicare plan and it’s still being offered, you don’t have to do anything. The coverage you have will continue.

What’s new for 2020?

The end of the Medicare Part D donut hole. The Medicare Part D coverage gap or  “donut hole” will officially close in 2020. If you have a Medicare Part D prescription drug plan, you will now pay no more than 25% of the cost of both covered brand-name and generic prescription drugs after you’ve met your plan’s deductible (if any), until you reach the out-of-pocket spending limit.

New Medicare Advantage features. Beginning in 2020, Medicare Advantage (Part C) plans will have the option of offering nontraditional services such as transportation to a doctor’s office, home safety improvements, or nutritionist services. Of course, not all plans will offer these types of services.

Two Medigap  plans discontinued. If you’re covered by Original Medicare (Part A and Part B), you may have purchased a private supplemental Medigap policy to cover some of the costs that Original Medicare doesn’t cover. In most states, there are 10 standard types of Medigap policies, identified by letters A through D, F, G, and K through N. Starting in 2020, people who are newly eligible for Medicare will not be able to purchase Medigap Plans C and F (these plans cover the Part B deductible which is no longer allowed), but if you already have one of those plans you can keep it.

If you would like to review your current investment portfolio or discuss any medicare or health insurance questions, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

College Disrupted: Students Face High Costs and Pandemic Impact

Even in normal times, it can be challenging for families to cover college expenses without borrowing money and/or risking their own retirement security. For the 2019-2020 academic year, the cost of in-state tuition, fees, room, and board at a four-year public college averaged $21,950, and the total for a private college approached $50,000 (1).

Sadly, the college world is not immune from the health fears and financial pain inflicted by the coronavirus pandemic. More students might choose schools that are less expensive and/or closer to home, take a year off, or forgo college altogether. The American Council on Education predicted a 15% decline in college enrollment nationwide for the next academic year (2).

With the financial futures of students and supportive parents at stake, it is more important than ever for families to make informed college decisions.

Reopening plans

As of August 5, 2020, about 29% of the nearly 3,000 institutions tracked by The Chronicle of Higher Education had announced plans for an online fall semester, 23.5% were planning to hold classes primarily or fully in person, 16% were proposing various hybrid models of in-person classes and remote learning, and the remainder were still undecided (3).

To reduce campus density and make room for social distancing in classrooms and residence halls, many colleges are inviting 40% to 60% of students back to campus (prioritizing freshman or seniors, certain majors, programs with clinical requirements, and students with unsafe home situations, for example) while expanding and improving remote teaching capabilities for students studying at home (4). Some colleges have backtracked on earlier plans to reopen due to a surge of the virus, and more could follow suit as events unfold (5).

A new landscape

Students who live on campus or attend classes in person are likely to find strict rules and restrictions regarding safety practices (physical distancing, face coverings, virus testing) and changes in many facets of campus life, including living situations, food options, class settings, social gatherings, and popular extracurricular programs such as arts and athletics.

Acknowledging that students are not getting the college experience they wanted and are now more price sensitive, many schools are freezing tuition, and others are offering discounts, increasing scholarships, or allowing students to defer payments (6). In anticipation of $23 billion in revenue losses, colleges nationwide have also had to lay off employees, reduce salaries, eliminate programs, and make other budget cuts (7-8).

In mid-March, Moody’s Investors Service downgraded the outlook for higher education from stable to negative, citing reduced enrollment. Institutions with large endowments and/or strong cash flows are better positioned to withstand the crisis, but lost tuition poses a bigger threat to smaller colleges (9).

Shopping for schools

High school students who are involved in the planning and application process might be lucky to enter college after the worst of the health crisis is over. Still, more economic hardship means that cost could play a greater role in school selection.

Many students don’t pay published tuition prices, and financial aid packages differ from school to school. After identifying schools that might be a fit, families can use net price calculators to compare how generous different colleges might be, based on the household’s financial situation and the student’s academic profile.

Before choosing a school, students should understand how much they might have to borrow and what the monthly payment would be after college. It’s also important to take a hard look at earning potential when choosing an academic program. Those who plan to enter lower-paying fields may fare better if they keep costs down and borrowing to a minimum.

Seeking financial aid

To receive grants and/or loans, students must complete the Department of Education’s Free Application for Federal Student Aid (FAFSA) and apply for aid according to the college’s instructions as early as possible. Higher-earning families should also fill out the FAFSA because they may qualify for more need-based aid than they might expect, and some schools may require a completed FAFSA for merit-based scholarships.

College students with parents who have lost a job or earned less income than normal this year due to COVID-19 may want to appeal for a revised aid package, if not for fall then for spring. The financial aid administrator may be able to reduce the loan component of a student’s aid package and/or increase the scholarship, grant, or work-study component.

Will college pay off?

The average college graduate earns $78,000 per year, compared with about $45,000 for the average worker with a high school diploma. The wages of workers without a college degree tend to fall more during recessions, and they are more likely to be unemployed, as seen during the pandemic (10).

A 2019 Federal Reserve analysis of the cost (four years of tuition and lost wages) and the benefits (higher lifetime earnings) concluded that a college degree is a sound investment for most people; the average rate of return for a bachelor’s degree is about 14% (11).

When Fed economists adjusted this analysis to account for the 2020 pandemic, the return on a college degree rose to 17% (under the assumption that many workers with a high school diploma would be unemployed for a year). For a student who takes a gap year, the estimated return dropped to 13%. The $90,000 cost of a delay includes one year’s worth of post-graduation earnings and slower growth in wages over a lifetime (12).

Remote learning may not be a perfect substitute for in-person interactions and relationships, especially for students enrolled at expensive institutions. Still, motivated students can grow intellectually and work toward a degree that could be valuable in terms of future earnings and social mobility.

Many colleges may be able to utilize their investments in technology and online curriculums long after the pandemic passes, providing future undergraduates with more opportunities to earn an affordable college degree remotely.

If you would like to review your current investment portfolio or discuss any college planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

(1) College Board, 2019

(2)(7) American Council on Education, 2020

(3) The Chronicle of Higher Education, August 5, 2020

(4)(9) The New York Times, July 7, 2020, and May 12, 2020

(5) NPR.com, July 22, 2020

(6)(8) Inside Higher Ed, April 27, 2020, and June 29, 2020

(10)(11)(12) Federal Reserve Bank of New York, 2019-2020

IRS Clarifies COVID-19 Relief Measures for Retirement Savers

The Coronavirus Aid, Relief, and Economic Security (CARES) Act passed in March 2020 ushered in several measures designed to help IRA and retirement plan account holders cope with financial fallout from the virus. The rules were welcome relief to many people, but left questions about the details unanswered. In late June, the IRS released Notices 2020-50 and 2020-51, which shed light on these outstanding issues.

Required minimum distributions (RMDs)

One CARES Act measure suspends 2020 RMDs from defined contribution plans and IRAs. Account holders who prefer to forgo RMDs from their accounts, or to withdraw a lower amount than required, may do so. The waiver also applies to account holders who turned 70½ in 2019 and who would have had to take their first RMD by April 1, 2020, as well as beneficiaries of inherited retirement accounts.

One of the questions left unanswered by the legislation was: “What if an account holder took an RMD in 2020 before passage of the CARES Act and missed the 60-day window to roll the money back into a qualified account?”

In April, IRS Notice 2020-23 extended the 60-day rollover rule for those who took a distribution on or after February 1, 2020, allowing participants to roll their money back into an eligible retirement account by July 15, 2020. This seemingly left account owners who had taken RMDs in January without recourse. However, IRS Notice 2020-51 rectified the situation by stating that all 2020 RMDs — even those received as early as January 1 — may be rolled back into a qualified account by August 31, 2020. Moreover, such a rollover would not be subject to the one-rollover-per-year rule.

This ability to undo a 2020 RMD also applies to beneficiaries who would otherwise be ineligible to conduct a rollover. (However, in their case, the money must be rolled back into the original account.)

This provision does not apply to defined benefit (pension) plans.

Coronavirus withdrawals and loans

Another measure in the CARES Act allows qualified IRA and retirement plan account holders affected by the virus to withdraw up to $100,000 of their vested balance without having to pay the 10% early-withdrawal penalty (25% for certain SIMPLE IRAs). They may choose to spread the income from these “coronavirus-related distributions,” or CRDs, ratably over a period of three years to help manage the associated income tax liability. They may also recontribute any portion of the distribution that would otherwise be eligible for a tax-free rollover to an eligible retirement plan over a three-year period, and the amounts repaid would be treated as a trustee-to-trustee transfer, avoiding tax consequences.1

In addition, the CARES Act included a provision stating that between March 27 and September 22, 2020, qualified coronavirus-affected retirement plan participants may also be able to borrow up to 100% of their vested account balance or $100,000, whichever is less. In addition, any qualified participant with an outstanding loan who has payments due between March 27, 2020, and December 31, 2020, may be able to delay those payments by one year.

IRS Notice 2020-50

To be eligible for coronavirus-related provisions in the CARES Act, “qualified individuals” were originally defined as IRA owners and retirement plan participants who were diagnosed with the virus, those whose spouses or dependents were diagnosed with the illness, and account holders who experienced certain adverse financial consequences as a result of the pandemic. IRS Notice 2020-50 expanded that definition to also include an account holder, spouse, or household member who has experienced pandemic-related financial setbacks as a result of:

  • A quarantine, furlough, layoff, or reduced work hours
  • An inability to work due to lack of childcare
  • Owning a business forced to close or reduce hours
  • Reduced pay or self-employment income
  • A rescinded job offer or delayed start date for a job

These expanded eligibility provisions enhance the opportunities for account holders to take a CRD.

The Notice clarifies that qualified individuals can take multiple distributions totaling no more than $100,000 regardless of actual need. In other words, the total amount withdrawn does not need to match the amount of the adverse financial consequence. (Retirement investors should consider the pros and cons carefully before withdrawing money.)

It also states that individuals will report a coronavirus-related distribution (or distributions) on their federal income tax returns and on Form 8915-E, Qualified 2020 Disaster Retirement Plan Distributions and Repayments. Individuals can also use this form to report any recontributed amounts. As noted above, individuals can choose to either spread the income ratably over three years or report it all in year one; however, once a decision is indicated on the initial tax filing, it cannot be changed. Note that if multiple CRDs occur in 2020, they must all be treated consistently — either ratably over three years or reported all at once.

Taxpayers who recontribute amounts after paying taxes on reported CRD income will have to file amended returns and Form 8915-E to recoup the payments. Taxpayers who elect to report income over three years and then recontribute amounts that exceed the amount required to be reported in any given year may “carry forward” the excess contributions — i.e., they may report the additional amounts on the next year’s tax return.

The Notice also clarifies that amounts can be recontributed at any point during the three-year period beginning the day after the day of a CRD. Amounts recontributed will not apply to the one-rollover-per-year rule.

Regarding plan loans, participants who delay their payments as permitted by the CARES Act should understand that once the delay period ends, their loan payments will be recalculated to include interest that accrued over the time frame and reamortized over a period up to one year longer than the original term of the loan.

Retirement plans are not required to adopt the loan and withdrawal provisions, so check with your plan administrator to see which options might apply to you. However, qualified individuals whose plans do not specifically adopt the CARES Act provisions may choose to categorize certain other types of distributions — including distributions that in any other year would be considered RMDs — as CRDs on their tax returns, provided the total amount does not exceed $100,000.

For more information, review IRS Notices 2020-50 and 2020-51, or talk to us.

1Qualified beneficiaries may also treat a distribution as a CRD; however, nonspousal beneficiaries are not permitted to recontribute funds, as they would not otherwise be eligible for a rollover.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

2020: Not Your Average Election Year

If you decided to take a long nap on New Year’s Eve and just woke up today, looked at your account statements, you might have yawned at how unchanged and boring the market must have been. You’d probably think, “on average, the market has been unchanged.”

But that’s the problem of averages when it comes to the stock market — they can wall-paper over a lot of painful experiences, like the tech bubble of 1999-2000, and the housing bubble of 2006-2007.

Considering the health catastrophe created by COVID-19, the strong rebound in stocks since the late-March low is astounding, especially given the deep economic damage. But given that the stock market is a forward-looking discount mechanism, it suggests that the collective wisdom of investors is more optimistic than the evidence that we hear and read about every day.

Stock markets continue to express little concern about the many uncertainties in this environment. Stock market valuations have met or exceeded their pre-crisis levels by most measures and continue to expand despite the major ongoing risks. Existing home sales in June of 4.7 million exceeded a record level on the back of falling interest rates, even as the number of unemployment claims ticked up last week for the first time in four months.

Federal Reserve support, rock bottom interest rates, the re-opening trade, and stronger economic data have helped. I also believe investors are looking past this year’s hit to corporate profits and are expecting an upturn in 2021.

The jump in daily COVID cases has created some renewed volatility, and it bears watching, but it has yet to knock the bulls off course. New all-time highs in the stock market in the weeks ahead would not surprise me one bit (the NASDAQ index has already done it). Even more surprising, it’s entirely possible that we’ve embarked on a new bull market.

While we are cautiously optimistic and giving this market the benefit of the doubt, we are maintaining our defensive allocation, primarily due to the persistent level of exuberance in the markets and resulting current overvaluation, as well as the uncertainty around possible rollbacks in re-openings.

Ultimately, the path of the virus will play the biggest role in how the economic outlook unfolds. Some folks are itching to get back to normal, while others remain on guard against the disease and are taking a more cautious approach. It may take time for some businesses to fully recover. Some never will.

Last month I opined, “I don’t expect a return to a pre-Covid jobless rate anytime soon. But investors are betting that an economic bottom is in sight.”

Try to look past continued volatility. With elections coming up this year, I expect more wacky market moves to go along with the typical wacky political moves we always see in a presidential election year. Regardless, based on recent economic reports, I think we hit bottom in April.

Those worried about a return to the March lows currently don’t have much evidence in terms of stock market action to support their worries. With so much money on the sidelines, it seems that every little dip is getting bought by those left behind in the panic.

If you liken the February-March stock market crash to an earthquake, then sure, you may feel some tremors and aftershocks for months, but the likelihood of another earthquake within a short period of time is highly improbable.

What to Do

None of us expected an economic upheaval spawned by a health crisis as the year began. But it pays to discuss some of the lessons and takeaways from the COVID-19 crisis.  And as I discuss them, you’ll probably recognize some of the themes (yes I do repeat myself frequently, like a nagging parent). Let’s not forget that the fundamentals—the core financial precepts—are always the building blocks of any credible financial plan.

1. Money at the end of your month

Saving for an emergency cannot be underestimated. Six to nine months of spending needs is optimal. But there is an added benefit—financial peace of mind.

It’s reflected in the proverb “The borrower is servant to the lender.” It’s not that I would counsel against a mortgage for a home or a reasonable loan for a car. But accumulation of wants (not needs) with (credit card) debt doesn’t bring contentment.

Instead, it brings stress. I have seen it over and over. You want money at the end of your month, not month at the end of your money.

A financial cushion eliminates one of life’s worries.

2. Wants vs. needs

Many of us have learned to do without certain things during quarantine. Whether we wanted to or not, we were forced to cut back on certain items.

Ask yourself this question, “As businesses re-open, are there things I can do without? Can I continue to cut back and still maintain my lifestyle?”

Many of our entertainment options have been curtailed. As we emerge from our homes and businesses reopen, are there items that can be trimmed from the budget?

It’s not a cold turkey approach, i.e. no more eating out, sporting events, travel or theater. But can we reduce expenditures on some items without sacrificing our overall lifestyle?

3. Diversification and tolerance for risk

We’ve just witnessed an unusual amount of stock market volatility. Calling it a roller coaster does not fully capture the experience (and most amusement parks are still shuttered!)

The major indexes have erased much of their losses. Yet, how did you fare emotionally when stocks took a beating? Now is the time to reevaluate your tolerance for risk. We’d be happy to assist and make any adjustments as they relate to your longer-term financial goals.

4. Expecting the unexpected

From its March 2009 low to the February 2020 high, the bull market ran for over 10 years (measured by the S&P 500 Index). We know bear markets are inevitable, but I recognize that the onset of a steep decline may be unnerving.

Nonetheless, a well-diversified portfolio of stocks has historically had an upside bias. That upside bias is incorporated into the recommendations we make, even as our recommendations are tailored to your individual circumstances and goals.

Further, a mix of fixed income and contra-funds helped cushion the decline. While we monitor events and the markets over a shorter-term period, let’s be careful not to take our eyes off your longer-term goals.

Be proactive, not reactive

The ideas above are a broad overview and individual circumstances may vary.

Taking inventory is critical. It’s half the battle. Be proactive, not reactive. You may find you are in a much better position than you realized. As always, we are here to help.

I hope you’ve found this review to be helpful and educational.

I understand the uncertainty facing all of us. We are grappling with an economic and a health care crisis. It’s something none of us have ever faced. We have addressed various issues with you, but I have an open-door policy. If you have questions or concerns, let’s have a conversation. That’s what I’m here for.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch. We start with a specific assessment of your personal situation. There is no rush and no cookie-cutter approach. Each client is different, and so is your financial plan and investment objectives.

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